Frightened? Not Financial Stocks

August 02, 2004

By Amey Stone To say that investors in Citigroup (C) and Prudential Financial (PRU) took the latest terrorism warnings in stride would be putting it mildly. Although they and other financial stocks opened weak the morning of Aug. 2, they rallied throughout the day. Citigroup actually gained 23 cents, to close at $44.32. Prudential made it back to $46.10, a 46 cent loss on a day in which it got as low as $45.52. In fact, most indices of financial stocks, such as Standard & Poor's Financial Select Sector SPDR Fund (XLF), traded higher for the day. XLF was up 6 cents, to $28.70.

Sorry, short sellers. It seems investors saw reason to hold onto their financial stocks in the face of heightened warnings of terrorist attacks. That heartening result reflects some positive trends in the sector that have taken place since September 11, 2001 changed the business climate for these companies forever (see BW Online, 8/3/04, "Are the Markets Steeled to Terror?").

First, financial companies have led the corporate world in preparations for dealing with future terrorist actions. They have redundant trading operations, backup data, and well-rehearsed plans in place for employees that would minimize the impact of any attack. "Financial institutions are pretty much at the forefront when it comes to being able to reroute their different operations," says Michel Leonard, U.S. chief economist at Aon's (AOC) Trade Credit group.

AT HOME IN THE WORLD. The buoyant market for financial stocks on Aug. 2 reflects investors' conclusion that there isn't much a terrorist network could do short-term to disrupt trading or cripple the economy. "With a company like Citigroup operating in 100 countries, you couldn't knock out the entire company by hitting one building," says Peter Cohan, an author and management consultant in Marlborough, Mass.

After the emotional shock had subsided, most investors realized that even an attack the magnitude of September 11 was only mildly disruptive, and firms are much better prepared now. "The psychological home of many of these companies is in Manhattan, but the financial sector is actually pretty diverse," says Nicholas Bohnsack, a strategist with research firm International Strategy & Investment (ISI).

While some investors now shrug off the government's warnings, having seen them come and go without incident in recent years, others likely take heart at the increased security they inspire. A successful terrorist attack is a lot less likely after an announcement than it was before the terrorist plot was revealed.

BAD REPUTATIONS? That's the short-term view. Longer term, the big financial companies will continue to feel the impact of the heightened risk of terror. Citigroup, for example, has to spend more money to protect employees in all the places they operate - not just New York. That will affect their ability to price their financial products competitively, says Richard Bove, who covers the company for Hoefer & Arnett. "The key point is that it will have an impact on the company," he says.

Plus, Bove feels identifying Citigroup and Prudential as targets of al-Qaeda could mar those companies' reputations in the Arab world. "It sends a subtle message through the Arab community that maybe this isn't the best bank for them to be doing business with," he says. "I don't think that is helpful at all."

The heightened anxiety of employees at financial firms could also negatively impact productivity, even though that's hard to quantify. "On the surface, people are going into work and proceeding as usual," says Paul Bernard, an executive coach at Paul Bernard & Associates in New York. "But I think there's more anxiety in the air. People are more stressed out, and more interpersonal issues are arising." For example, Bernard says he received far more crisis calls from clients today than he does on a typical Monday.

WILD OPTIMISM. Finally, as much as financial firms have done to prepare for a terrorist attack, "being the victim of an attack would have repercussions, such as interruption of operations, reputational risk, and human capital risks," says Aon's Leonard. Investors have little doubt that if one of these firms were struck, their stocks would sell off dramatically.

America may be the land of optimism but it takes a very optimistic investor indeed to conclude that government warnings of a terrorist plot on financial firms are a reason to buy these stocks. But, at least on Aug. 2, buy is what many investors did. Even as he was scratching his head over why, Brian Williamson, an equity trader at the Boston Company Asset Management, had to admit, "that's a pretty positive sign." Stone is a senior writer at BusinessWeek Online and covers the markets as a Street Wise columnist